How Do Taxes on Stock Trades Work?
So, you made a lot of money on your last swing trade? Congrats! But now the hard part, figuring out the taxes on stock trades. You may be asking yourself: “How do taxes on stock trades work?” This isn’t an uncommon question to have, given the nuanced manner in which taxation works on investment profits. Today we’ll be exploring and discussing the different taxes on stock trades, how they work and how you pay them.
Taxes on Stock Trades: Background
The taxes paid on investment profits is known as capital gains. There are two different types of capital gains taxes, determined by how long you held the investment for. The two types of capital gains taxes are long-term and short-term capital gains. The cost basis is the baseline used to determine gains or losses. The cost basis calculation includes using not only the cost of the security itself, but also any applicable commissions.
You also need to be aware of whether or not the security you hold pay dividends. Qualified dividends are taxed based on your federal tax bracket, though on a 0/15/20 percent scale. And ordinary dividends is based on your federal tax bracket. For more information on the taxes on stock trades paying qualified dividends, consider speaking to a tax professional.
Long-Term vs. Short-Term Capital Gains
Long-term capital gains apply to profits gained from securities that you held for over one year. As of 2021, a single person making up to $41,675 annually would pay 0% in long term capital gains. A person making $41,676 to $459,750 would pay 15%. Anyone making over $459,751 would pay 20% on their long-term capital gains.
Short-term capital gains apply to profits from securities that you hold for less than one year. Assessing short-term capital gains is based on your federal tax bracket. For that reason, short-term capital gains can have a much higher tax penalty than long-term capital gains. And, this increase is more likely to be noticed the higher your regular income is. However, understanding both is most important for paying taxes on stock trades. For those earners making between $41,775 and $170,050, they will be taxed either 22 or 24 percent. Compare that to the 15% that they would be paying if they held for over one year. Any [single] salary above $170,051 will fall into any of the 32, 35 or 37 percent tax brackets.
For those who are not filing their taxes as a single, the taxes are quite different. The taxes for those married lower income earners filing separately are identical to those filing as a single. For those filing as head of household, or married filing jointly, please check the associated tax brackets. All those making above $41,775 as a single or married filing separately should do the same. In addition, for all those high-income earners, an extra 3.8% tax will be applied to all gains. While complicated, understanding your tax bracket and filing status will ensure you properly pay the taxes on stock trades.
If you lose more money than you made, you can offset your regular income. This process, known as tax-loss harvesting, allows you to offset up to $3,000 from your regular income. In addition, you can carry these losses forward to later years. Money held in some retirement accounts aren’t taxed until the funds are withdrawn. However, funds held in Roth IRA or 529 accounts are not taxed at all. As it applies to a Roth IRA, an increase in your income may restrict your ability to contribute at all. If your money is in a 401k, investment growth, interest, dividends and investment gains are not taxed. In addition, donating stock can also wipe out any potential capital gains taxes. Stock held for over one year, and donated to a qualified charity, are not subject to capital gains taxes.
Taxes on Stock Trades Conclusions
This article is meant to build off of my previous article, about tax season tips. Understanding the confusion around taxes in general, tackling the taxes on stock trades seemed like a logical next step. Hopefully, through the information that was provided above, you have a better understanding of how the process works. In short, your overall holding period, federal tax bracket, and filing status all impact your capital gains. There are also different ways to utilize potential losses, or to “hide” your gains. These strategies range from tax-loss harvesting, to utilizing tax advantaged investment accounts, and even to philanthropy. Together, all this information should help you be more prepared as you go through tax season.
About Gabriel Shabat
Gabriel Shabat is a writer who focuses on financial literacy and investing topics. He has been studying and talking about the markets for over seven years. Last year he became a part of the instructional staff at Boston University, teaching graduate finance courses as part of their Masters degree programs. When he isn’t working, he enjoys playing the guitar, working out and spending time with his loved ones.